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The duty of good faith and reasonableness: too much pizza, too little dough

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The obligation to act with “good faith and reasonableness” is a relatively modern, and continually evolving, area of contract law. This principle recently received some further consideration from the Federal Court of Australia in a legal battle concerning a topic of fundamental national importance: the price of pizza.

Entrée: the price of the menu

In Virk Pty Ltd (in liq) v YUM! Restaurants Australia Pty Ltd the Full Court of the Federal Court was invited to expand this novel area of contract law. The facts of the dispute are as follows. Back in 2014 the parent company behind Pizza Hut decided to introduce a new business plan, which it called the “value strategy”.

The “value strategy” was compulsory for all franchisees and required that the company’s four ranges of pizzas be rebranded into two. The first was a “classics” range which was to be priced at $4.95. The second was a “favourites” range which was to be priced at $8.50. This represented a significant drop in price (in some cases up to 50%) from Pizza Hut’s previous products. In announcing the “value strategy”, Pizza Hut relied on a contractual power in its franchise agreements to set maximum prices.

The franchisees cried foul, arguing that the model would cripple their ability to survive financially. The franchisees banded together and attempted unsuccessfully to obtain an injunction to prevent Pizza Hut from implementing the business plan. Whilst Pizza Hut and the franchisees were battling this out in court, Dominos, Pizza Hut’s major competitor, introduced a similar pricing structure – beating Pizza Hut to the punch.

Main course: a duty to act reasonably?

Despite being unsuccessful in stopping the introduction of the business plan, the franchisees continued the fight all the way to the Full Court of the Federal Court. The argument was concerned with the obligation to act with “good faith and reasonableness”.

This modern concept of contact law essentially stands for the proposition that, in formation, construction, and interpretation of a contract the parties are required to act in “good faith”, and this obligation is discharged by the parties acting honestly and reasonably.

The franchisees sought to argue that there were separate, but correlated, duties: a duty to act in good faith, and a duty to act reasonably. On this basis, the franchisees essentially submitted that Pizza Hut had breached a duty similar to a duty to take reasonable care, by exercising a contractual right in such a way that would produce an unreasonable outcome for the franchisees. Should this argument be accepted it would expand the doctrine of good faith to import elements of the tort of negligence into contract law.

Just desserts?

The Court unanimously rejected this approach, holding that the obligation to act with good faith and reasonableness:

“is to be considered in a composite and interrelated sense. To the extent that consideration is given to whether a party’s conduct is reasonable or not, it is directed to the primary component of the obligation, namely of good faith. Reasonableness is not to be approached in a case such as this as akin to a tortious duty to exercise due care and skill or to produce a reasonable outcome. Rather it goes to the quality of the conduct, here in exercising the price setting power, to discern whether it was capricious, dishonest, unconscionable, arbitrary or the product of a motive which was antithetical to the object of the contractual power.”

Therefore, the consideration of whether or not an act is “reasonable” is only concerned with whether a party has acted in good faith. There is no separate duty to take reasonable care to avoid an unreasonable outcome. Accordingly, there was no expansion of the doctrine of good faith.

In any event, the Court found that Pizza Hut had not acted unconscionably or in bad faith. The Court concluded that, put simply, Pizza Hut had a contractual right to set a maximum price which it exercised. It did not do so dishonestly, arbitrarily, or capriciously. There was no undue influence, pressure, or unfair tactics used against the franchisees. The Court considered that the General Manager of Pizza Hut had considered the profitability of the franchisees in coming to the conclusion to implement the “value strategy”, particularly in the context of Dominos also implementing a similar model.

This case is a useful reminder as to the extent to which broad powers contained in a franchise agreement can be used by franchisors. It also provides another fence post of the boundaries of the developing area of good faith in contract law. We will continue to watch how this area of law develops, but, at least for now, a separate duty to act reasonably is a piece too far.



Luke Dominish

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